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by Charalambos Pissouros

US Yield Curve Inversion Deepens, GBP Gains on Brexit-related Headlines

EU indices traded in the green again yesterday, but during the US session, investors turned back cautious, with the US Treasury yield-curve inversion deepening and underscoring concerns with regards to a global economic downturn. In the FX world, the pound was the main gainer among the G10s, rising as UK opposition parties pledged to work together in order to avert a no-deal Brexit on October 31st.

Investors Turn Cautious Again as US Yield Curve Inversion Deepens

The dollar continued trading higher against most of the other G10 currencies on Tuesday and during the Asian morning Wednesday. It gained against NZD, CAD, AUD, CHF, EUR and JPY in that order, while it underperformed notably against GBP and slightly versus NOK. The greenback was found virtually unchanged against SEK.

USD performance G10 currencies

The performance in the FX world does not paint a clear picture with regards to the broader market sentiment and indeed, looking at equities, the picture appears to be mixed as well. Major EU indices traded in the green, with investors keep adding to their risk exposures following Trump’s remarks that China contacted Washington to express willingness for returning to the negating table. They may have gotten an extra boost by headlines that Italy’s Democratic Party (PD) abandoned a veto on PM Conte, which suggests that the party is even closer to reaching common ground with the FiveStar Movement in order to form a coalition government.

US Treasury yield curve

Having said that though, the optimism did not last for long. US indices traded in the red, weighed down by a deepening of the US Treasury yield curve inversion. The yield on 10-year Treasuries slid to 1. 49%, below the 2-year yield of 1.54%, resulting in the deepest inversion since May 2007 and underscoring concerns with regards to a global economic downturn. The softening investor morale was evident today as well, with Asian indices trading mixed. Although Japan’s Nikkei 225 was 0.11% up, China’s Shanghai Composite slid 0.29%.

Major global stock indices performance

Yesterday morning, we noted that on Monday investors may have turned too optimistic with regards to the US-China trade saga and Tuesday’s market response during the US session confirms that view. We repeat that rhetoric by itself is far from suggesting that the two nations have moved closer to a deal.  After all, following Monday’s “goodwill” calls, neither nation announced that tariffs will be removed. With planned tariffs set to kick in on September 1st, we can’t say that the worst is behind us. Further escalation could lead to another round of risk aversion, and the only thing that could keep additional equity declines in check may be willingness from central banks worldwide to do even more in order to support their economies.

DJIA – Technical Outlook

The Dow Jones Industrial Average cash index traded lower yesterday, but the slide was stopped by the 25720 zone, from where the index rebounded somewhat. Overall, Dow is trading within a sideways range, that’s been containing most of the price action since August 5th, between 25280 and 26420. Thus, without any clear trending structure on the 4-hour chart, we would adopt a neutral stance with regards to the near-term outlook.

A clear dip below 25720 could open the gate for further declines, perhaps towards the lower end of the sideways range, at around 25280. That said, we would like to see a decisive close below that hurdle before we start examining whether the picture has started turning negative. Something like that may initially allow extensions towards the low of August 6th, at around 25075, or towards the psychological zone of 25000.

Taking a look at our short-term oscillators, we see that the RSI lies slightly below 50 and points sideways, while the MACD lies slightly below zero, but above its trigger line. Both indicators detect weak negative momentum, and that’s why we prefer to wait for a dip below 25720 before we get confident on a decent negative leg within the aforementioned range.

On the upside, we would like to see a strong break above 26420 before we start examining whether the bulls have gained the upper hand. This could signal the upside exit out of the range, and may initially target the 26705 hurdle, which is slightly above the high of August 2nd, and slightly below the low of July 31st. Another break, above 26705, may extend the recovery towards the 27000 territory.

Dow Jones Industrial Average cash index 4-hour chart technical analysis

GBP Gains as UK Opposition Parties Agree to Stop a No-deal Brexit

Back to the currencies, the pound was yesterday’s main gainer, coming under strong buying interest after UK opposition parties agreed to work together in an attempt to stop a no-deal Brexit by legislation. The talks were hosted by Labour Leader Jeremy Corbyn, who apparently eased his stance, as his initial plan of a no-confidence vote and a caretaker government appeared to be lacking support. The rally in sterling suggests that investors believe passing a legislation with regards to averting a disorderly exit is a more feasible outcome. That said, it still remains to be seen whether it will gather majority among members of Parliament, who return to Westminster from their summer holiday next week.

GBP performance G10 currencies

Besides the agreement between opposition parties, we also had headlines surrounding a telephone conversation between UK PM Boris Johnson and EU Commission President Jean-Claude Juncker. Johnson reiterated his stance that there is no prospect of a deal unless the Irish backstop is abolished, while Junker noted that he is willing to look at any concreate proposals on alternatives, as long as they are compatible with the Withdrawal Agreement. Juncker’s comments come after German Chancellor Angela Merkel, and even French President Emmanuel Macron, kept the door open for a solution over the backstop last week, which suggests that EU officials may have started softening their stance.

As for our view, we stick to our guns that, bearing in mind how pessimistic market participants had been over Brexit recently, anything suggesting willingness to avert a chaotic divorce could continue being more-than-welcome by GBP-traders. However, we are still reluctant to trust that we are experiencing the beginning of a long-lasting recovery. The aforementioned agreement still has to gain majority in Parliament, while any alternative with regards to the Irish backstop has to be accepted by all EU member states. With Ireland’s Foreign Minister Simon Coveney saying that existing alternatives are “not even close” to being accepted, we see the case for Johnson coming up with something that has not been discussed over the last three years, and gathering the EU’s broad support, as a hard task.

 For now, we would prefer to exploit any further near-term pound gains against AUD and NZD. Due to Australia’s and New Zealand’s trading exposures to China, both currencies are extremely sensitive to developments surrounding the US-China sequel, with anything pointing to further tensions having the potential to push them lower. What’s more, both the RBA and the RBNZ have been sitting in front seats with regards to global monetary policy easing, having already cut rates this year, by 50 and 75 basis points respectively, and signaling that they could do more.

GBP/NZD – Technical Outlook

GBP/NZD surged yesterday, breaking above the 1.9335 barrier, which is near the high of August 25th, but the advance was stopped at around 1.9410, near the high of June 14th. The pair has been drifting north above a short-term uptrend line since July 30th, and thus, we would see a positive short-term picture.

If the bulls are strong enough to overcome the 1.9410 barrier, then we may see them aiming for the psychological zone of 1.9500, the break of which may allow larger upside extensions, perhaps towards the 1.9580 territory, defined by the high of May 22nd.

Shifting attention to our short-term momentum studies, we see that the RSI is slightly below its 70 line and points up, while the MACD lies above both its zero and trigger lines. Both indicators detect positive speed and corroborate the case for some further near-term advances in this exchange rate.

In order to start examining the case of a downside correction, we would like to see a retreat back below the 1.9260 zone, which is near the high of August 22nd. Something like that may allow declines towards the 1.9100 area, or the aforementioned uptrend line taken from the low of July 30th.

GBP/NZD 4-hour chart technical analysis

As for Today’s Events

The calendar appears to be light today as well, with no top-tier indicators on the schedule. The only release worth mentioning is the EIA (Energy Information Administration) weekly report on crude oil inventories, which is expected to reveal a 2.1mn barrels slide, after a 2.7mn decline the week before. That said, bearing in mind that yesterday, the API report revealed a 11.1mn tumble, we would consider the risks surrounding the EIA forecast as tilted to the downside.

We also have two speakers on the agenda: Today, during the US session, we will hear from Richmond Fed President Thomas Barkin, while during the Asian day, San Francisco Fed President Mary Daly will step up to the rostrum.

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